Abstract
We now explore the main critiques of the general bank regulatory framework and suggest necessary reforms that can address the specific aspects of bank bankruptcy. We first address prudential regulation in banking. Second, we analyze whether systemically important public infrastructure can be separated from the rest of the banking system. Third, we analyze the rationale for netting, and last of all we propose how to contain systemic repercussions caused by the closeout netting provisions of derivative contracts.
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Notes
- 1.
Adrian and Brunnermeier (2010) propose macroprudential regulation based on CoVaR measure of interconnectedness between financial institutions. CoVaR measures the value-at-risk of the financial system. In particular, the contribution of an individual institution towards systemic risk is defined as the difference between the CoVaR in the case of the financial institution’s distress and the CoVaR in the case of a normal state of the financial institution.
- 2.
In this light one may understand the main role of the European Systemic Risk Board (the newly built EU body for systemic risk mitigation), which is making informed proposals that others (regulators or policymakers) should implement. However, the ESRB is not independent from banking regulators. See Section 6.3 for further discussion.
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- 4.
- 5.
Baer et al. (1996).
- 6.
In the EU, Directive 98/26/EC precludes insolvency proceedings from having retroactive effects (see European Parliament and Council 1998). The amendments in Directive 2009/44/EC have been proposed to deal with increasing interlinkages between multiple payment systems that may increase systemic risk in the financial system (see European Parliament and Council 2009 and Weber and Gruenewald 2009 for discussion).
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Bear Stearns, Lehman Brothers, AIG, JP Morgan Chase, and other investment banks and dealers extensively used this market to fund themselves before the onset of the credit crisis in 2007.
- 8.
In some countries, the set-offs are widely applicable to every contract and not only to bank contracts (Bergman et al. 2003).
- 9.
Ivashina and Scharfstein (2010) show that corporations had drained their credit lines when the 2007–2009 financial crisis started.
- 10.
House Rep. No. 97–420, 97th Cong., 2nd Sess., 3 (1982). The amendments to the Bankruptcy code in 2005 increased the privileges of derivative contracts from a limited number of contracts (e.g., Treasury repos and a few futures contracts) to a wide range of financial contracts such as secured financial credit (e.g., repurchase agreement). In the EU, the main directives dealing with financial collateral are the EU Financial Collateral Directive of 6 June 2002 (OJ L 168/43) and the EU Settlement Finality Directive of 19 May 1998, but these were subsequently amended several times (by Directive 2009/44/EC of 6 May 2009 and Directive 2002/47/EC).
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Marinč, M., Vlahu, R. (2012). General Issues on the Structure of Banking Industry. In: The Economics of Bank Bankruptcy Law. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-21807-1_5
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